There Are Reasons To Feel Uneasy About Scholar Education Group's (HKG:1769) Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Scholar Education Group (HKG:1769), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What is it?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Scholar Education Group is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.049 = CN¥45m ÷ (CN¥1.5b - CN¥563m) (Based on the trailing twelve months to June 2021).

Therefore, Scholar Education Group has an ROCE of 4.9%. Ultimately, that's a low return and it under-performs the Consumer Services industry average of 8.2%.

View our latest analysis for Scholar Education Group

Above you can see how the current ROCE for Scholar Education Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Scholar Education Group here for free.

What Does the ROCE Trend For Scholar Education Group Tell Us?

In terms of Scholar Education Group's historical ROCE movements, the trend isn't fantastic. Around four years ago the returns on capital were 44%, but since then they've fallen to 4.9%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Scholar Education Group has done well to pay down its current liabilities to 38% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Scholar Education Group. But since the stock has dived 86% in the last year, there could be other drivers that are influencing the business' outlook. Regardless, reinvestment can pay off in the long run, so we think astute investors may want to look further into this stock.

If you want to continue researching Scholar Education Group, you might be interested to know about the 4 warning signs that our analysis has discovered.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.